Commodity Futures Trading for Beginners

By Bruce Babcock

The Truth About Commodity Markets

In order to be a successful trader, you must understand the true realities of the markets. You must learn how the professionals make money and what is possible. Most traders come into commodity trading, lose a substantial portion of their capital and then leave trading without ever having a correct perception of what good trading is all about.

For many years college professors have argued that the markets are both random and highly efficient. If this were true, it would be impossible to gain an edge on other investors by having superior knowledge or a superior approach.

Professional traders, who make their living trading rather than studying the markets from afar, have always laughed at these ivory tower theories. A good example is George Soros, who has made billions of dollars from trading and is perhaps the greatest trader of all time. Here is how he responds to these ivory tower academics: "The [random walk] theory is manifestly false--I have disproved it by consistently outperforming the averages over a period of twelve years. Institutions may be well advised to invest in index funds rather than making specific investment decisions, but the reason is to be found in their substandard performance, not in the impossibility of outperforming the averages."

Mathematicians have conclusively shown the financial markets to be what are called non-linear, dynamic systems. Chaos theory is the mathematics of analyzing such non-linear, dynamic systems. The commodity markets are chaotic systems. Such systems can produce random-looking results that are not truly random. Chaos research has proved that the markets are not efficient, and they are not forecastable. Commodity market price movement is highly random with a small trend component.

Most beginning traders assume that the way to make money is to learn how to predict where market prices are going next. As chaos theory suggests, the truth is that the markets are not predictable except in the most general way.

In his book, Methods of a Wall Street Master, famous trader Vic Sperandeo, whose nickname is "Trader Vic," warns:  "Many people make the mistake of thinking that market behavior is truly predictable. Nonsense. Trading in the markets is an odds game, and the object is always keep the odds in your favor."

Luckily, as Trader Vic suggests, successful trading does not require effective prediction mechanisms. Good trading involves following trends in a time frame where you can be profitable.

The trend is your edge. If you follow trends with proper risk management methods and good market selection, you will make money in the long run. Good market selection refers to trading in good trending markets generally rather than selecting a particular situation likely to result in an immediate trend.

There are three related hurdles for traders. The first is finding a trading method that actually has a statistical edge. Second is following it with consistency. Third is consistently following the method long enough for the edge to manifest itself on the bottom line.

This statistical edge is what separates speculating from gambling. In fact, effective trading is actually
like the gambling casino rather than the gambling customer. Professional trader Peter Brandt explains successful trading in just this way: "A successful commodity trading program must be based on the simple premise that no one really knows what the markets are going to do. We can guess, but we don't know. The best a commodity trader can hope for is an approach which provides a slight edge. Like a gambling casino, the  trader must earn his profits by exploiting that edge over an extended series of trades. But on any given trade, like an individual casino bet, the edge is pretty meaningless."

Unsuccessful and frustrated commodity traders want to believe there is an order to the markets. They think prices move in systematic ways that are highly disguised. They hope they can somehow acquire the "secret" to the price system that will give them an advantage. They think successful trading will result from highly effective methods of predicting future price direction. These deluded souls have been falling for crackpot methods and systems since the markets started trading.

Prolific futures trading author Jake Bernstein describes how these desperate traders are victimized: "Futures trading is ultimately very simple. Any attempt to make trading complex is a smokescreen. Yet for self-serving reasons an army of greed-motivated promoters try to make things complicated. Too many market professionals consider it their mission in life to obfuscate. Why? Because in so doing they give the appearance that their efforts are scholarly and important. They create a need for more information, and then they fill it!"

Books on how to trade commodities are famous for showing a few well-chosen examples where a described prediction method previously worked. They never show what would have happened if you had applied the method religiously for many years in numerous markets. Those who have tested these methods have found that in the long run almost all of them don't work. Be wary of any trading method unless you see a detailed demonstration showing that it has worked for at least five to ten years in a variety of different markets using exactly the same rules.

The job of the person who wants to trade commodities rationally and prudently is to ignore the
promises of those promoting pie-in-the-sky prediction mechanisms and concentrate on finding and implementing a proven, integrated methodology that follows market trends.

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TRADING IN COMMODITY FUTURES OR OPTIONS INVOLVES SUBSTANTIAL RISK OF LOSS.
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

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